Capital outflows form a leading risk and the rand remains particularly volatile.

Medium- and long-term political risk classification (MLT) in 4/7

After being classified in 3/7 for more than a decade, South Africa’s MLT risk classification was downgraded to 4/7 in August 2016. Structural domestic strains together with incoherent government policies and mismanagement obstructed economic rehabilitation after a series of external shocks: the 2009 financial crisis, the drop in commodity prices and severe droughts. As a result, South Africa’s macroeconomic fundamentals deteriorated structurally, leading to the downgrade in 2016. Although the country is confronted with significant challenges, no additional downgrade is anticipated for now.

South Africa has a greatly diversified economy with a global footprint (mining, agriculture, financial services, tourism, manufacturing, etc.). However, its global market presence and investment inflows have been diminishing, while flat and low GDP growth performance remains a major challenge. In 2018 and 2019 GDP growth is expected to reach merely 0.8% and 1.4% respectively. Economic growth is held back by policy uncertainty (2019 presidential elections) and structural domestic shortcomings, like endemic unemployment (28% of the labour force), low household consumption and savings, a deficient education system, infrastructure bottlenecks, recurrent labour unrest and corruption. Introducing a recovery plan to tackle these long-standing deficiencies will be particularly tricky for President Ramaphosa, especially given today’s tight fiscal conditions and low investor confidence.

South Africa is exposed to capital outflows in light of global monetary normalisation, rising US interest rates and negative investor sentiment towards emerging markets. As its structural current account deficit (about 3% of GDP expected in 2018) is largely financed by portfolio and other investments (bonds and equities held by foreigners), capital outflows pose an important balance of payments risk. Fortunately, South Africa’s foreign exchange reserves are at adequate levels (4.3 months of import cover in June 2018) and the exchange rate is flexible which implies that outflows result in depreciation rather than in depleting reserves. Moreover, the country’s financial market is deep and sophisticated. External debt and debt service ratios are on the rise but remain at sustainable levels. However, South Africa traditionally holds large short-term external debts, raising the rollover risk in case of a shock. During the nine years of Zuma’s patronage-based politics, tax collection contracted and tax evasion soared which – together with mismanagement at major state-owned enterprises (e.g. power utility Eskom) – degraded public finances and public debt sustainability. The public debt stock is anticipated to reach 55.7% of GDP this year and grow to up to 60% by 2021. Government interest payments are likely to absorb more than 13% of 2018 public revenues, the highest level in almost 15 years.

The rand has been particularly volatile over the past few years (cf. graph) due to terms-of-trade shocks and foreign investor anxiety fuelling episodes of sell-offs. When President Ramaphosa took office at the end of 2017, the rand quickly strengthened, although it lost nearly 20% again since the beginning of 2018. This can be explained partly by ongoing policy uncertainty and economic woes in vulnerable emerging markets like South Africa, reflected by the plummet of the Turkish lira and Argentine peso. The rand slide could fuel inflation, which is nonetheless projected to balance around 5-6% subject to tight monetary policies (interest rates might increase over the coming months).

Forthcoming elections

In February 2018, newly elected ANC party leader Cyril Ramaphosa was sworn in as president, after a tense period marked by political scandals and uncertainty. Ramaphosa’s win somewhat reduced the risk of civil unrest while his immediate anti-corruption and pro-business rhetoric was awarded with positive domestic and international reactions. However, since the economic slowdown of the past six months, enthusiasm has toned down.

The political scene will be dominated by general elections due by August 2019. Ramaphosa will focus on his ‘war on graft’ and on cleaning up the ANC’s wrenched reputation while enhancing party unity. Recent testimonies by finance minister Nhlanhla Nene about state capture and corruption, led to the first cabinet reshuffle under President Ramaphosa, with the aim of restoring public trust in the government. Commonly respected former South African Reserve Bank governor Mboweni was appointed as new finance minister, leading to immediate gains for the rand. However, pending corruption probes might raise pressure on other ministers as well.

Land reforms will be an important campaign topic, as successive ANC governments failed to thoroughly address large dispossessions of black South Africans during colonial times and apartheid. The proposed constitutional amendment to allow for land expropriation without compensation raised fears among investors and industrial farmers over property prices, banking stability and even food security. Ramaphosa has sought for calm by emphasising that Zimbabwe-style ‘land grabs’ should not be feared as strict limitations to the policy will be applied. It remains to be seen whether the ANC can introduce a type of ‘expropriation without compensation’ that tackles the detrimental inequality while limiting damage to economic prospects and investor confidence. Moreover, the land reform should be sufficiently attractive to withhold the electorate from turning to the more radical rhetoric of the Economic Freedom Fighters (EFF).

Ramaphosa would need to win a strong mandate to embark on delicate reforms that are vital for boosting growth and unlocking the country’s enormous potential. However, given recent economic setbacks, the ANC might as well be punished for years of negligence. Indeed, large parts of the population lost confidence in the ANC, as was emphasised already during the 2016 municipal elections by local party losses in favour of the Democratic Alliance (DA).